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Ilker Domaç is an economist in the East Asia Pacific Region at the World Bank, and Ghiath Shabsigh is an economist in the Middle Eastern Department at the IMF. The authors wish to thank Messrs. Mohammed Dairi, Hamid Faruqee, Wim Fontenyne, Edward Gardner, Gaston Gelos, Daniel Hardy, Christopher Lane, and Milan Zavadjil for useful comments.
Indeed, Fischer (1987) recognized the importance of RERMIS and argued for the inclusion of avoidance of an overvalued exchange rate to Haberger’s thirteen rules for good economic policy management (1984).
These countries were selected due to their recent experience with stabilization and economic reform. It should also be noted that, since the empirical investigation was carried out on the collective data of the four countries, the results may not apply equally to individual countries.
The risk of having an undervalued exchange rate that creates a large trade surplus and a very strong traded goods sectors is more difficult to recognize.
These relationships give credence to the notion of using a RERMIS measure that is determined by a structured model, which would capture policy induced misalignment, to study its effect on economic performance.
Under a quantitative management system, the allocation of foreign exchange resources among different uses is entirely a function of administrative decision and excludes any role for a price mechanism in determining foreign exchange allocation. A cost management approach (sometimes referred to as Multiple Currency Practices) involves the introduction of a variety of taxes, subsidies and regulations that can produce similar effects on international transactions as the MER system can.
The MER systems in these countries were introduced either as a simple premium over the official rate (as in Morocco and Jordan) or a more elaborate regime of complex and fragmented MER for various transactions (as in Egypt).
By the end of 1976, the foreign exchange market was fragmented into three pools: (i) the central bank pool which was mainly reserved for transactions by the central government (ii) the commercial bank pool which governed the transactions of the public sector companies and, (iii) the free market pool for private sector transactions.
An attempt at unifying the exchange rate was carried out in January of 1985 by prohibiting imports through the “own exchange market” and depreciating the exchange rate in the commercial banks pool. The reform proved unsuccessful and was rescinded in April 1985.
In response to the weakening of the US dollar (USD) in 1985 and to the resulting appreciation of the dinar, the link to SDR was replaced by a basket of currency with the weight of the USD higher than its weight in the SDR.
In practice, the dirham was linked to the FF. The link to other currencies in the basket was through the cross rates established in the Paris exchange market. The exchange system, however, remained highly centralized.
Except for a series of small adjustments in 1992.
A recent study by Clark and MacDonald (1998) compares two approaches for evaluating the degree by which a country’s real effective exchange rate is in line with economic fundamentals.
By selecting the three highest values of the RER as a reference, one chooses devaluation years that may or may not be “equilibrium years”. Nevertheless, since devaluations generally occur at times of balance of payment crises or when the external sector is clearly out of equilibrium, it is reasonable to assume that the RER is closer to equilibrium when a devaluation takes place than otherwise.
NDEV is treated as an exogenous variable since it is a policy instrument that is often used by policy makers to achieve real exchange rate devaluation.
This measure assumes that money demand has a unitary elasticity with respect to real income.
The two widely quoted papers concerning the impact of the RER misalignment on the economic performance—Cottani et al. (1990) and Ghura and Grennes (1993)–did not investigate the time series properties of the variables involved in their investigation. This casts some doubts on the validity of their empirical findings; if the variables of interest are integrated of different orders, regression results using such variables will not be reliable.
All data used in this study were obtained from World Bank’s World debt tables, International Monetary Fund’s International Financial Statistics and World Economic Outlook, and World Currency Year Book. The sample period is 1970–95.
The instrument list for the estimation includes constant, current and once lagged values of the exogenous variables, US inflation, and population growth.
Note that the computation of RERMIS excluded the variables NDEV, TOT, and t, because the aim is to calculate the policy induced part of the misalignment which is captured by EXCR, CAPFY, and CLOSE.